Behavioural Effects of Variances: Staff Motivation, JIT and TQM

A purchasing officer in a Lagos food factory is judged on the material price variance. In March a supplier offers a 4% discount for an order that will last three months, and the officer accepts. The month-end report shows a handsome favourable price variance and the officer is praised.

Three months later the factory has a store full of flour that is going stale, a bank overdraft that has grown, and a warehouse lease it had to extend. The variance was favourable; the company was worse off. Variances measure the difference between actual and standard, but people respond to how they are measured, and they will often improve the measure rather than the business.

This topic explains the effects of variances on staff motivation and behaviour; why some variances are dysfunctional in a just-in-time (JIT) or total quality management (TQM) environment; the behavioural problems of using standard costs in a rapidly changing environment; and how to reduce them. It builds on the earlier topic on overhead variances and reconciling budgeted and actual profit. The next topic covers profitability ratios and financial performance measures.

Variances and staff motivation

Why variances affect behaviour

Variances and budgetary control are accepted as a tool of performance measurement if staff believe they will not be blamed for deviations that come from poor planning or faulty standard setting. But managements often treat a variance as evidence of inefficiency, so that staff feel held responsible. How variances are used therefore shapes motivation and action, for better or for worse.

Negative effects of unmanaged or unfair variances

• Demotivation and frustration: a sense of being blamed unfairly, lower morale, reduced effort.
• Burnout: staff driven to meet unattainable standards; absenteeism and resentment may rise.
• Defensiveness and resistance to change: staff protect themselves, hide problems and resist innovations that change the standards.
• Lower quality and productivity: pressure to hit targets at any cost; shortcuts.
• Manipulation: reports adjusted, costs moved between periods, honest forecasts withheld.

Positive effects of well-managed variances

• Motivation and commitment when performance is shown to be good and the system seen as fair.
• Continued improvement in productivity and a culture of continuous improvement.
• Collaboration and open communication, since staff discuss variances to find causes.
• Ownership and accountability: staff act to remove deviations.
• Targeted improvement: areas needing attention are isolated and corrected.
• Fairness and transparency, and lower costs and better operations.

The difference between the two lists is mainly whether standards are realistic, whether variances are reported only to those who can control them, and whether they are used to learn or to punish.

JIT, TQM and rapidly changing environments

Variances in a JIT environment

JIT aims to hold minimum stock of materials and finished goods, produce only to meet demand, and eliminate waste, so reducing storage cost and improving cash flow. Traditional variance analysis concentrates on individual cost items and on short-term cost reduction. Used in a JIT plant, it can reward behaviour that works against JIT:

• Material price variance: favourable variances reward buying in bulk, at the cheapest supplier, in large quantities, building stock; JIT needs small, frequent deliveries from reliable suppliers, perhaps at a higher price.
• Labour efficiency and idle time variances: a manager avoids an adverse idle time variance by keeping workers busy, producing for stock that no customer has ordered.
• Fixed overhead volume and capacity variances: a favourable volume variance comes from producing more than was budgeted, so a manager has an incentive to overproduce, again building stock.
• Material usage: pressure to avoid adverse usage may delay the stopping of a line to correct faults.

For variance analysis to be useful in JIT, the emphasis should move to total cost, to throughput and delivery performance, and to continuous improvement, with non-financial measures such as lead time, set-up time and stock levels.

Variances in a TQM environment

TQM aims to reduce cost through continuous improvement and customer satisfaction, aiming at zero defects. Variances can conflict with it:

• Standards that allow for waste (a normal loss or an attainable standard) accept a level of defects, while TQM seeks to remove them.
• An adverse material price variance may push managers to buy cheaper, lower-quality material, which raises scrap, rework and returns, and harms customers.
• Variances measure cost, not quality, delivery or customer satisfaction, so a manager may meet the cost standard while quality falls.
• Short-term control of variances can discourage investment in training and process improvement whose benefits come later.
• Employees are less willing to report problems if they are blamed for the variances those problems cause. TQM needs a culture in which problems are brought to light and used to improve, which is what the right use of variances should support.

Behavioural problems of standard costs in a rapidly changing environment

Standards are often based on history, assumptions or averages, which may not reflect current markets, customer preferences or production efficiency.

In a fast-changing environment this causes:

• an over-focus on unfavourable variances arising from unattainable targets
• manipulation of data under pressure
• neglect of true performance improvement and innovation
• resistance to change when standards are not flexed to match changing conditions
• low morale and disengagement
• poor pricing, production and strategic decisions based on inaccurate costs
• misallocation of resources, with attention on variances rather than the real drivers of performance

Reducing the problems

• Keep standards current and review often; use ex post standards and report operational variances, so that planning errors are not blamed on managers.
• Use attainable, challenging standards, set with staff participation, with the idea of continuous improvement built in.
• Add non-financial measures (quality, delivery, lead time, satisfaction) and judge performance on a balance of measures.
• Look at variances together and at the total result, not one item in isolation, and report to the manager who can control the item.
• Use variances to investigate and learn, not to blame; encourage staff to report problems.
• Reward overall performance (profit, throughput) and not individual variances.

Layouts for testing the effect of a variance on behaviour

1. Compute the variance the manager sees (for example a favourable price variance on the order placed).
2. Compute the hidden cost of the behaviour it provokes (holding cost, cost of unsold stock, rework).
3. Compare: net effect on the company = variance − hidden cost.
4. Name the behaviour and the remedy.

Money is in naira and each answer is rounded once, at the end.

Worked examples

1. Variance seen.
   20,000 × (100 − 98) = ₦40,000 F.
2. Extra stock held. Buying monthly the average stock is about 5,000 kg; buying two months at a time it is about 10,000 kg, so 5,000 kg extra.
   Over the two months: 5,000 × 12 × 2 = ₦120,000 extra holding cost.
3. Net effect.
   40,000 − 120,000 = ₦80,000 worse off, although the report shows a favourable variance.
4. Behaviour and remedy. The purchasing officer is rewarded for the price alone. Judge purchasing on total cost, including holding cost and quality, and agree small, frequent deliveries from reliable suppliers.

1. Variance avoided.
   Idle time of 400 hours × 500 = ₦200,000 no longer appears.
2. Cost incurred.
   Materials 200 × 1,500 = ₦300,000 tied up in stock that may not be sold, with storage and risk of damage.
3. Net effect. The wages were paid anyway; the company spends ₦300,000 to hide a ₦200,000 variance and is ₦300,000 worse off in cash until the stock is sold. Under JIT the right response is to report the idle capacity, look for orders or reduce capacity.

Expect variants: a case describing a plant that has just moved to JIT or TQM and asking which variances are now misleading, a requirement to discuss the motivation effects of a budget system, and suggestions for the right measures.

Conditions for successful just-in-time, and level production against JIT

Suppliers: materials of near-perfect quality, delivered on time, in small frequent deliveries, from a few suppliers with long-term close relationships. Production: a smooth flow of production, a pull system (work in one process starts only when the next process needs it, so output follows customer demand), quick and cheap set-ups because runs are short, and preventive maintenance to avoid breakdowns.

Employees: multi-skilled, flexible and empowered, working in teams and responsible for quality. Stocks are kept near zero, so there is no buffer against defects or late delivery.

Level production against JIT. Example. Quarterly demand 300,000, 360,000, 540,000 and 420,000 units (total 1,620,000); regular capacity 450,000 a quarter; holding cost ₦20 per unit a quarter on average stock. Level production makes 405,000 each quarter: closing stock 105,000, 150,000, 15,000 and 0. Average stock 52,500, 127,500, 82,500 and 7,500 gives holding costs of ₦1.05m, ₦2.55m, ₦1.65m and ₦0.15m: ₦5.4m for the year. Under JIT, production equals demand, so holding cost is nil, but quarter 3 needs 540,000 units, which is 90,000 above regular capacity.

If overtime costs an extra ₦75 of labour (50% premium) and ₦10 of variable overhead (25% more) per unit, the extra cost is 90,000 × 85 = ₦7.65m. JIT saves ₦5.4m but costs ₦7.65m: a net cost of ₦2.25m, so with fluctuating demand and limited capacity JIT is not financially beneficial unless other savings (less waste, less space, quality) outweigh it.

Machine utilisation, throughput accounting and inventory

Machine utilisation rate = hours required to meet maximum demand ÷ hours available. Machine 1: 560 required, 500 available, 112%; machine 2: 360 required, 450 available, 80%. The machine above 100% is the bottleneck. Under throughput accounting only materials are variable, so labour paid a guaranteed wage is a fixed cost, and for perishable products where stock should be kept to a minimum the approach suits well.

Example. Price ₦600, ₦900, ₦700 and materials ₦200, ₦300, ₦250 for P, Q and R give throughput ₦400, ₦600, ₦450; machine 1 hours 2, 4 and 2.5 give throughput per hour ₦200, ₦150 and ₦180. Demand P 100, Q 50, R 60; machine 1 has 500 hours. Make P (200 hours), R (150 hours), then Q with the 150 hours left (37.5 units): throughput 40,000 + 27,000 + 22,500 = ₦89,500.

Inventory. Throughput accounting does not treat stock as an asset; it is a sign of unsynchronised production and a barrier to profit. The ideal stock is zero except a buffer before the bottleneck. Stock is valued at material cost only, because no value is added and no profit earned until the item is sold.

This contrasts with absorption costing, which values stock at full cost, so that overproduction spreads overhead and raises reported profit, and which therefore encourages managers to build stock. If demand also exceeds regular plus overtime capacity under a JIT plan, the contribution on the shortfall is lost too.

Cost per factory hour, a minimum contract, and raising bottleneck capacity without new machines

Cost per factory hour = total factory cost ÷ bottleneck hours available (after allowing for utilisation). Example. Factory cost ₦10.8m; the bottleneck runs 12 hours × 5 days × 50 weeks × 90% = 2,700 hours; cost per hour ₦4,000. Red panels throughput ₦7,000 a unit in 1.4 hours = ₦5,000 an hour; TAR = 5,000 ÷ 4,000 = 1.25. Black panels ₦2,160 in 0.6 hours = ₦3,600 an hour; TAR = 0.90, so each hour on black panels earns less than it costs.

A guaranteed minimum supply (say 1,000 black panels) is made first, then the best-ranked product (red) with the hours left.

Ways to raise bottleneck output without new machines:

• do maintenance outside production hours (contractors work around the clock)
• cross-train staff so that absence does not idle a machine
• stagger lunch breaks so that the bottleneck keeps running
• lengthen the working day or add a working day
• make sure the bottleneck never waits for work (a buffer of stock before it)

Common mistakes

• Listing behavioural problems without naming the variance that causes them.
• Saying variances are always bad for motivation. Fairly used, they help.
• Ignoring the quality side of TQM and writing only about cost.
• No remedy. Always state how to reduce the problem.
• Confusing JIT with TQM. JIT concerns inventory and flow; TQM concerns quality and customers.
• Treating a favourable variance as always good.

Quick revision

• Staff accept variances if not blamed for bad plans. Unfair variances demotivate; fair ones motivate.
• JIT: price variance → stock; efficiency/volume variance → overproduction.
• TQM: allowances for waste, cheaper inputs, cost not quality.
• Fast change: out-of-date standards. Remedies: review, ex post, non-financial measures, total result.

How the marks are earned

• Link each variance to its behaviour.
• Quantify the hidden cost where numbers are given.
• Recommend remedies.

Practice questions

These are original questions, written in the style of the Skills examination. Work each one before you open the answer.

Recall check: multiple choice

Section B style: written questions

Model answers

Spotted a mistake? Tell us and we will check it.